1031 exchanges for Los Angeles investors
A 1031 exchange lets you sell an investment property and reinvest in another without paying capital gains tax at the time of the sale. It works best when it’s planned before you list, not after. Here’s how standard, reverse, improvement, and out-of-state exchanges work, and where a DST fits in.
- CA Real Estate Broker, DRE #01884303
- LAMERICA Real Estate
- Investor with 17 rental units across three states
What is a 1031 exchange?
A 1031 exchange, named after Section 1031 of the Internal Revenue Code, lets you defer capital gains taxes, including depreciation recapture, when you sell real estate held for investment or business use and buy other “like-kind” real estate. Like-kind is broad: a rental house can be exchanged for a duplex, an apartment building, land, or commercial property, in California or another state. The taxes aren’t eliminated, they’re deferred, which lets you keep more of your equity working for you. Your primary residence doesn’t qualify on its own, but it can be combined with an exchange in some situations, as explained below.
Watch: 1031 exchange strategies with a qualified intermediary
On The Key to the City of Angels, I sat down with Brendan Lewis, Senior Vice President at Asset Preservation, Inc., a national qualified intermediary that facilitates 1031 exchanges in all 50 states.
1031 Exchange Secrets: How Savvy Investors Avoid Capital Gains Taxes, with Brendan Lewis of Asset Preservation, Inc.
Key takeaways
- Go in with a plan. The 45-day identification window is where exchanges go wrong. Investors who haven’t decided what to buy can rush into a property they shouldn’t own.
- Set it up before you close. Once your sale closes without an exchange in place, it’s too late. Setting one up keeps your options open even if you’re not sure you’ll buy.
- Bring your advisors in early. Decisions made in a silo are costly. Your CPA, agent, and financial advisor should all know the plan.
- You can combine tax breaks. If you live in part of a property and rent the rest, you may be able to use the home sale exclusion on your part and a 1031 on the rental part.
- An exchange isn’t always the answer. Sometimes a cash-out refinance, or simply paying a modest tax bill, fits your goals better.
Why LA owners are exchanging now
Most of my recent listings were rental properties, and the owners’ reasons tend to fall into three categories:
Policy
Rent control and tenant protections in Los Angeles have made owning rentals here riskier. One bad tenant can cost months of rent plus legal fees.
Management
Many owners are tired of managing tenants and repairs, and want something more passive, like a triple net property or a DST.
Equity
After years of appreciation, many owners are sitting on equity that could buy far more property elsewhere. One of my clients sold for just over $1 million and used the same equity to buy about $2 million of property.
How a standard 1031 exchange works
Set up a qualified intermediary
Before your sale closes, you hire a qualified intermediary. They hold your sale proceeds so you never touch the money, which is required for the exchange to work.
Identify within 45 days
You have 45 days after your sale closes to identify replacement property in writing. Most investors identify up to three properties to give themselves backups.
Close within 180 days
You have 180 days after your sale closes to complete the purchase. Both deadlines run at the same time, and neither is extended for weekends or holidays.
Reinvest everything
To defer all of the tax, you generally need to buy property of equal or greater value and reinvest all of your net proceeds. Any cash you keep is taxable.
Forty-five days goes fast, especially when you’re buying in a market with low inventory. That’s why I plan the replacement property with you before we list, so you’re not starting your search after the clock is already running.
Living in part of the property? Combining a 1031 with the home sale exclusion
If you live in part of a property and rent out the rest, like a duplex or a house with a rented ADU, you may be able to use two tax breaks on one sale. The portion you live in may qualify for the home sale exclusion, which lets you exclude up to $250,000 of gain, or $500,000 for married couples filing jointly, if you meet the ownership and use requirements. The rented portion can go into a 1031 exchange.
I did this myself when we sold our home in Granada Hills. We lived in the main house and rented out the ADU. Most of the gain was tax-free under the home sale exclusion, and since I planned to buy another investment property anyway, I used a 1031 exchange on the ADU portion, so I didn’t have to pay back the depreciation.
Splitting a sale this way takes careful records and coordination with your CPA, but for owners of homes with ADUs, it can make a real difference.
Reverse and improvement exchanges
Reverse exchange: buy first, sell second
A reverse exchange lets you buy your replacement property before your current property sells. An exchange accommodation titleholder temporarily holds title, and you then have 180 days to sell. It costs significantly more than a standard exchange, and you need to fund the purchase without your sale proceeds. At Los Angeles price points, where the taxes at stake are often large, the added cost is easier to justify.
Improvement exchange: use exchange funds to improve
An improvement exchange lets you buy a less expensive replacement property and use the remaining exchange funds for improvements, like a value-add property that needs work. The improvements generally have to be completed within the 180-day window. It adds cost and complexity, so it only makes sense when the improvement budget is substantial.
Exchanging from Los Angeles into out-of-state property
A 1031 exchange isn’t limited to California. Many LA investors sell here and exchange into rental property in other states, where prices are lower and landlord rules can be more predictable.
I’ve done it myself. I sold my condo in Los Angeles and exchanged into a fourplex in one state, through a 50/50 partnership, and a triplex in another. One condo with HOA dues became seven rental units. It wasn’t perfectly smooth: my first target was a market where property managers wouldn’t take on the buildings I was considering, and I had to change my strategy partway through. If a property manager won’t manage it, you probably shouldn’t buy it. That’s exactly the kind of lesson that’s better learned before your 45 days start.
There’s one California-specific rule to know: when you exchange California property into property in another state, California tracks the deferred gain and requires an annual information filing, Form 3840, for as long as you own the replacement property. Your CPA handles this, but it’s worth knowing before you start.
Out-of-state exchanges are where planning matters most. Many agents focus only on the sale, and the replacement purchase in another state isn’t their concern. I plan both sides with you, and I can connect you with a vetted agent in the market you’re buying in.
My own example: Granada Hills to out-of-state rentals
When I sold my own Granada Hills home, which had a tenant-occupied ADU, I followed the same process I use with clients. The exchange was planned before listing, the ADU lease and paperwork were ready on day one, and we sold with the tenant in place. Most of the gain was tax-free under the home sale exclusion, and a 1031 exchange on the ADU portion went into rental property out of state.
- 2 offersin the first week
- 98.76%of list price
- 2 tax breakshome sale exclusion and a 1031 exchange
Done managing properties? Exchanging into a DST
Some owners want to sell, defer their taxes, and stop being a landlord altogether. A Delaware Statutory Trust, or DST, can be an option. A DST owns larger, professionally managed properties, such as apartment communities or net-leased commercial buildings, and investors buy a fractional interest. Under IRS Revenue Ruling 2004-86, DST interests can qualify as like-kind replacement property in a 1031 exchange.
DSTs offer passive ownership, with no tenants to manage and no repairs to handle, and they can close quickly, which some investors use as a backup when a direct purchase falls through. The tradeoffs: you give up control over the property, your money is typically tied up for years, fees can be significant, and DSTs are generally available only to accredited investors.
DST interests are securities. They’re offered through licensed securities professionals, not real estate agents. I can sell your property and help you plan the exchange, and I recommend working with a licensed financial advisor on the DST side. All investments carry risk.
Is an exchange right for you?
A 1031 exchange should be part of a larger strategy, not just a way to avoid taxes. A few things to weigh:
- If there’s any chance you’ll reinvest, set up the exchange before you close. Once your sale closes without one, you can’t go back. Keep in mind that once an exchange is set up, your proceeds stay with the qualified intermediary until the exchange is completed or ends, so plan for that.
- A small tax bill may not be worth it. If the taxes you’d owe are modest compared to the deal, simply paying them can be the better choice.
- Consider a cash-out refinance. If you like the property you have, pulling equity out with a refinance generally isn’t a taxable event, and it can fund your next purchase while you keep the original property.
- Think about when to sell. Buyers rarely pay extra for a new roof or HVAC system. Selling before major systems need replacing can save you money you wouldn’t get back.
Why I plan your exchange before we list
The biggest 1031 mistakes happen when owners list first and think about the exchange later. By then, the qualified intermediary may not be in place, the replacement search hasn’t started, and the 45-day clock is already ticking. Before we list, we:
- Decide whether an exchange makes sense for your goals, using a free Equity Review
- Choose the type of exchange: standard, reverse, improvement, or into a DST
- Start looking at replacement property, in LA or out of state
- Coordinate with your CPA and qualified intermediary
- Time the sale so the deadlines work for you
Frequently asked questions
What are the 1031 exchange deadlines?
You generally have 45 days after your sale closes to identify replacement property in writing and 180 days to close on it. Both deadlines run at the same time and aren’t extended for weekends or holidays. The 180-day deadline can be shortened if your tax return is due first, so talk to your CPA about timing.
Can I do a 1031 exchange on my primary residence?
Not on its own. A 1031 exchange only applies to property held for investment or business use. If you’re selling your home, you may qualify for the home sale exclusion, which excludes up to $250,000 of gain, or $500,000 for married couples filing jointly, if you meet the ownership and use requirements.
Can I combine a 1031 exchange with the home sale exclusion?
In some cases, yes. If you live in part of a property and rent out the rest, such as a duplex or a house with a rented ADU, you may be able to apply the home sale exclusion to the part you live in and a 1031 exchange to the rented part. I did this when I sold my own home in Granada Hills. It takes careful records and coordination with your CPA.
Can I sell in Los Angeles and exchange into property in another state?
Yes. A 1031 exchange isn’t limited to California. California does track the deferred gain and requires an annual information filing, Form 3840, while you own the out-of-state replacement property. I’ve done this myself: I sold my own home in Granada Hills, which had a tenant-occupied ADU, and exchanged into rental property out of state.
Should I set up an exchange if I’m not sure I’ll buy?
If there’s a real chance you’ll reinvest, it’s usually worth setting up before your sale closes, because you can’t start an exchange after closing. The main tradeoff is that your proceeds stay with the qualified intermediary until the exchange is completed or ends.
What is a reverse 1031 exchange?
A reverse exchange lets you buy your replacement property before selling your current one. An exchange accommodation titleholder temporarily holds title during the process. Reverse exchanges cost more and are more complex, and you need to fund the purchase without your sale proceeds.
What is an improvement exchange?
An improvement exchange lets you use exchange funds to make improvements to a replacement property, such as a value-add property that needs work. The improvements generally must be completed within the 180-day window, and the added cost means it only makes sense for substantial projects.
What happens if I miss a deadline?
If you miss the 45-day or 180-day deadline, the exchange generally fails and the sale becomes taxable. That’s why planning before you list matters so much.
Can I 1031 exchange into a DST?
Yes. Interests in a Delaware Statutory Trust can qualify as like-kind replacement property. DSTs offer passive ownership but come with less control, limited liquidity, and fees. They’re securities offered through licensed professionals, and they’re generally available only to accredited investors.
Do you give tax advice?
No. I’m a real estate broker, not a CPA or tax advisor. I help you plan and execute the real estate side of an exchange and coordinate with your CPA and qualified intermediary on the tax side.
This page is general information, not tax or legal advice. 1031 rules are complex and every situation is different. Confirm the details of your exchange with your CPA or tax advisor.
Thinking about a 1031 exchange?
Start with a free Equity Review. We’ll look at what you’d walk away with, whether an exchange makes sense, and what your next property could look like, before you list.
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